ECON 1P92 Lecture Notes - Aggregate Demand, Aggregate Supply, Demand Shock

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2 Feb 2013
Chapter 23: Output and Prices in the Short Run
Shocks and Price changes:
1. Exogenous changes in price level- demand side changes
2. Supply side changes- factor prices
3. Macro Equilibrium- demand, supply and price level
The Demand Side of the Economy:
Shifts in the AE Curve
1. Exogenous change in price level, P
Increase in P reduces the real value of money [in private sector]
Fall in P raises the real value of money holdings
Change in P affect wealth of bondholders and bond issuers [offset each other- no change in
aggregate wealth]
Changes in wealth affect Consumption [C]:
Increase in P reduces private-sector wealth
Decreases desired Consumption
AE curve shifts down
Fall in P increases private-sector wealth
Increases desired Consumption
AE curve shifts up
Price changes affect Net Exports [NX]:
Prices rise in Canada- foreign prices are constant
Canada’s Export fall Imports rise
Shifts the NX function leftward
AE curve falls
Conversely for a fall in Canada’s Prices
Changes in Equilibrium GDP
Prices increase, AE function shifts downward
An increase in P
Reduces private-sector wealth
Reduces desired AE
AE curve shifts down
Reduces equilibrium level of real GDP (Y)
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The Aggregate Demand Curve:
Aggregate Demand (AD) Curve
Relates equilibrium real GDP to the price level
For any given price level
AD curve shows level of real GDP where desired aggregate expenditure equals actual GDP
Changes in price level
Causes shifts in AE curve
Cause movements along AD curve
Increase in P
Shifts AE down
Equilibrium GDP falls
Decrease in P
Shifts AE up
Equilibrium GDP rises
Changes in P shown by movements along Aggregate Demand curve
Decline in P
Increase quantity demanded
When price is lower, buy more only applies to one good
With substitutes
Apples cheaper, so buy more apple and fewer bananas]
One case of substitutes:
If domestic prices fall
Buy more domestic goods
Buy fewer imports
Main reason:
Real wealth increases when P falls [Real Balances]
AD increases [shifts]:
At a given price level:
Any position shock [increase in Exports (X)]
Increases equilibrium GDP
Increases AD- shifts AD rightward
Any negative shock [fall in Investment (I)]
Decreases equilibrium Y
Decreases AD- shifts the AD leftward
K x change in A measures size of horizontal shift of AD curve
Exports rise
Price level constant
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